Prepared by Arabella Volkov University of Southern Queensland

1. Prepared by Arabella Volkov University of Southern Queensland

2. Debrefing – Chapter 7 Current cost accounting

3. Learning Objectives • At the conclusion of this lecture, you should have an appreciation of: • business profit, holding gains and the advantages of measuring these concepts • the debate regarding financial and physical concepts of capital

4. Learning Objectives • At the conclusion of this lecture, you should have an appreciation of: • the current cost accounting standards that have been recommended or are used throughout the world • the criticisms of current cost accounting

5. Learning Objectives • At the conclusion of this lecture, you should have an appreciation of: • the counter-arguments by currentcost theorists • the results of empirical studies

6. Rationale for Current Cost Accounting • Business profits =Current operating profit (COP) + Realisable cost savings/holding gains/losses (HG/L) (Edwards and Bell)

7. Why Holding Gains are a Component of Profit • Cost saving (actual acquisition cost < current cost) • Increase in the value of the assets – assets are worth more • Increase in the CC – indication of the future cash flow

8. Why Holding Gains are a Component of Profit • benefits • Can evaluate how successful the holding activities • Can better evaluate performance of management • Operating activities • Holding activities • Can better predict future cash flow

9. FC Capital = dollar amt invested PC Physical aspects (translated into dollars) Relates to firm’s producing capacity Financial Capital versus Physical Capital

10. HG – included in the profit HC – included in equity as capital maintenance adjustment Financial Capital versus Physical Capital

11. Financial Capital versus Physical Capital Which is more rational? Samuelson’s • Separation between holding activities n operating activities – not clear cut • Cost saving = HG = Opportunity gain? • Buy – past decision • Sell • Use • Net cash flow – neither realised nor expected The present choices

12. Rationale for Current Cost Accounting • Edwards and Bell • the expansion problem • the composition problem • the financing problem

13. Rationale for Current Cost Accounting • Edwards and Bell • Accounting information uses • Evaluation by managers of their past decisions in order to make the best possible decisions for the future • Evaluation of managers by shareholders, creditors and others

14. Rationale for Current Cost Accounting Holding gains and losses • In some cases holdings gains and current operating profit are not independent of each other • Confuses management evaluation • Hinders resource allocation • Are holding activities successful? • Comparing firm performance

15. Rationale for Current Cost Accounting Justifying including holding gains as profit (Revsine): A cost saving measures a firm’s cash position advantage relative to other firms in the industry that were not fortunate to hold the given asset while its price rose. When these other firms do buy the asset, they will have to do so at higher prices. As a consequence their cash outflow will exceed the cash outflow of the firm which experienced the cost saving.

16. Financial Capital versus Physical Capital CCA and calculating capital: • Valuation method accepted as current market buying prices but: • 2 definitions of capital and profit measurement • Basic difference is whether or not holding gains are included in profit

17. Financial Capital versus Physical Capital

18. Financial Capital versus Physical Capital • In support of physical capital • denotes firm’s operating capability • Major features of physical capital • Capital maintenance • Valuation principles • Non-monetary items • Monetary items and loan capital • Non-monetary assets bought & sold on the same market

19. Financial Capital versus Physical Capital • Criticisms of physical capital • different units • decreasing costs • same markets • partial investment

20. Current Cost – A Global Perspective Current cost in the United States • 1976 SEC amended Rule 3.17 Regulation S-X • 1979 FASB Statement 33

21. Current Cost – A Global Perspective United Kingdom • 1975 Sandilands Committee • 1976 Inflation Accounting Steering Group (IASG)-ED 18 • 1980 SSAP 16 • 1985 mandatory status of SSAP 16 withdrawn

22. Current Cost – A Global Perspective Australia –SAP 1 (1983) • Statement of accounting practice • Not mandatory • Recommended the presentation of CCA statements • As supplementary information • Or as a replacement to HC • Not widely adopted in Australia

23. Current Cost – A Global Perspective International Accounting Standards • IASB and FASB agree that best basis of measurement is fair value • Various fair value measurement models are used by IASB in standards • No mention of capital maintenance

24. Criticisms of Current Cost Advocates of historical cost • CCA violates realisation principle • Subjectivity of increase Advocates of exit price • Cost implies opportunity cost • Allocation problem (Thomas) • Current operating profits could be poor predictors of future profits (Lemke) • Additivity problem (Chambers)

25. In support of Current Cost • Recognition principle • Holding gains should be recognised if there is objective evidence of a price change • Objectivity of current cost • Depends upon visibility of market price item

26. In support of Current Cost • Technological changes • Is profitability expected to be higher with new technology? • Current cost v. exit price • Current cost is the normal valuation method

27. In support of Current Cost Comparison of the results with historical cost

28. In support of Current Cost Empirical studies • Australia • United States • New Zealand • United Kingdom • Research related to the IFRS

29. Empirical Evidence • Capital markets research • Supplementary current cost data not useful • Not value relevant for stock prices • Financial capital not used for valuation • Watts & Zimmerman alternative interpretations of results • Financial asset current costs appear to have more value relevance

30. Summary • Proponents of CCA believe it provides more useful information. • Financial capital concept • Physical capital concept • This view is not supported by empirical studies. • Watts and Zimmerman offer four alternative interpretations • Companies argue the cost of providing CCA information outweighs any benefit.

31. Key Terms and Concepts • Current cost • Holding gains and losses • Business profit • Physical capital • Recognition principle

32. Where to get more information • Other courses • List books • Articles • Electronic sources

34. Why Holding Gains are a Component of Profit Expected income = Market rate of return x Beginning value of net assets Unexpected income = Sporadic increases or decreases in present value of net assets due to change in expectations regarding the level of future cash flows